Banks are overvaluing toxic property loans, experts warn

Banks are significantly overvaluing assets to be included in the government’s insurance scheme, which could leave the taxpayer footing the bill for any shortfall, experts have warned.

Property loans – which will be part of the £575bn government’s asset protection scheme (APS) to ring-fence the most toxic assets of Lloyds Banking Group and Royal Bank of Scotland – will be dated as of the end of December 2008 although commercialreal estate values have fallen by just over 10% since then, according to data from the consultancy Investment Property Databank.

Matthew Oakeshott, the Liberal Democrat Treasury spokesman, said: “The APS is a ticking time-bomb for the British taxpayer. These poisonous property loans must have an independent, up-to-date valuation in accordance with the Rics [Royal Institution of Chartered Surveyors] valuation ‘red book’ when taxpayers actually go on the hook.

“If not, the APS will be a fraud on the British taxpayer – just like someone insuring a car after it has crashed.”

Oakeshott is writing a letter to the chancellor, Alistair Darling, raising his concerns about what he called “taxpayers being stung in an APS cover-up”. According to him, Britain should follow the Irish government, which is contracting independent valuers to put a price on banks’ property loans before they go into a so-called “bad bank”.

Governments around the world have designed programmes to insure, protect or ring-fence toxic assets to help re-establish confidence in the financial system and encourage banks to start lending again. RBS is putting about £60bn of commercial property loans into the APS, out of a total £315bn of assets, while Lloyds’ property loans in the scheme mount to £90bn, out of an overall £260bn, according to Credit Suisse estimates.

Industry specialists say any insured asset should be priced as realistically as possible. David Lovett, managing director of the restructuring firm Alix Partners, said: “The assets to be transferred should be valued at the date of transfer; it has to be at that date to ensure there is an accurate assessment and the issue has been resolved.

“To have a valuation of any other date has the potential for distorting the claim and creating an over- or an underpayment for the claim,” he said.

The government and the banks, however, claim the valuation date goes back to the end of last year because that is when coverage of the losses started. The taxpayer will pay 90% of any losses suffered by the two partially nationalised banks after a first loss to be taken by the banks.

Ann Cairns, managing director at the restructuring firm Alvarez & Marsal, said: “If the government insured portfolios at today’s prices, the insurance would be less expensive for the banks, but the value of that insurance would be limited.”

The banks are paying a fee to the government for insuring their toxic assets and analysts differ over whether they will be forced to shoulder losses above that level. The government made a £25bn provision for APS-related losses in the budget.

Jonathan Pierce, of Credit Suisse, estimates that the two banks’ losses will not surpass the £32bn that the banks are paying the government in fees. However, he added: “This is highly sensitive to small changes in the proportionate loss rate because the amount of assets is so big and the length of time that the assets are covered.”

Future losses depend on whether the economy recovers quickly enough, with predictions also varying widely. According to CB Richard Ellis, a real estate consultancy, property prices may only increase by 5% to 10% over five years, short of the near-30% decline in value since the peak of the market. BNP Paribas forecasts a rise of about 30%.

Analysts complain that the scheme has so many uncertainties that it is difficult to predict any outcome. Final details are not yet ready, after months of negotiations following the initial announcement in February. A deal may be struck later this month, a source said. Lloyds is also having second thoughts about it and has been sounding out investors about an alternative rights issue.

Analysts agree that the announcement of the scheme helped calm the markets at a time when bank shares were in freefall. But since then, the design of the APS has been slow to take shape and has failed to re-ignite inter-bank lending, critics say. People and firms are still finding it difficult, or expensive, to access finance and encourage economic growth.

Simon Adamson, credit analyst at CreditSights, said: “Clearly, it has taken a long time to put together and there are still a lot of doubts about how and when. It helped to restore confidence to banks but in terms of stimulating lending, it doesn’t really seem to have achieved much.”

Oakeshott believes it would be better to be more realistic and take the pain right away. “Japan’s long agony in the 80s and 90s after a property price crash should teach us one single lesson – it’s far better to take the pain up front and move on than trying to hide overvalued property off balance sheet for years on end,” he said. “Our government must not sweep this £500bn problem under the carpet until after the election.”